Defined benefit pension plan

Many small business owners and professionals have delayed saving for retirement for a variety of reasons. The cash balance plan or other hybrid defined benefit plans might be the solution. Depending on the demographics of your firm you could retain more tham 90% of the contributions to the plan. It is a win for your employees because you will contribute more for their retirement. You win because you can pack 20 years of saving into 10 years or less. Increasing your tax deductions while offering a benefit which will help attract and retain top talent.
English: The Frances Perkins Building located at 200 Constitution Avenue, N.W., in the Capitol Hill neighborhood of Washington, D.C. Built in 1975, the modernist office building serves as headquarters of the United States Department of Labor. (Photo credit: Wikipedia)

For a small but growing number of companies, cash balance plans offer a third alternative. Cash balance plans have existed for many years. However, until relatively recently, regulatory and legal uncertainty kept many companies from adopting these plans. Since cash balance plans have gotten the final stamp of approval from the IRS and the U.S. Department of Labor, their numbers have been increasing.Compared to the hundreds of thousands of 401(k) plans in existence, cash balance plans remain a relative drop in the bucket. According to the 2012 National Cash Balance Research Report published by Kravitz Inc., the number of cash balance plans increased 21% last year. The most recent IRS data from 2010 shows 7,064 active cash balance plans. Just ten years ago in 2001, that number was 1,337. However, the report found that growth of cash balance plans continues to outpace the growth in any other type of retirement plan.

The Pension Protection Act of 2006 has made is possible for many small business owners to pack 20 years of savings into 10. The regulation changing made make the defined benefit hybrid plans legal and very attractive. Although not for every business or professional firm when these plans work it is a win win for the employer and their employees.
President George W. Bush signs into law H.R. 4, the Pension Protection Act of 2006, Thursday, Aug. 17, 2006. Joining him onstage in the Eisenhower Executive Office Building are, from left: Secretary of Labor Elaine Chao; Rep. Buck McKeon of California; Rep. John Boehner of Ohio; Senator Blanche Lincoln, D-Ark.; Senator Michael Enzi, R-Wyo., and Rep. Bill Thomas of California. (Photo credit: Wikipedia)

Imagine this scenario: Greg is a 55-year-old client who has owned a highly successful marketing firm for 20 years. He has three employees in their 20s and early 30s who make between $20,000 and $35,000 a year, while Greg takes home $200,000 a year. Greg is looking for a retirement plan that will allow the maximum contribution and provide the biggest tax deduction and savings. Greg has not saved as much for retirement as he would like because his focus has been getting his children through college. He is now ready to contribute as much as possible to a retirement plan, as he wants to retire in the next five to 10 years.How would you advise this client?

While small business owners typically use defined-contribution plans with an elective deferral feature to provide retirement benefits to employees, defined-benefit plans may be ideal for small-business owners over 50 who are interested in saving a substantial amount of money for retirement in a short time period.

Defined-benefit plans promise a specific annual retirement benefit based on the percentage of current income the business owner wants to have at retirement, or the percentage of current income he or she can comfortably afford to contribute, up to an annual maximum of $200,000. These plans are best suited for small business owners who are at least 40, earn $100,000 or more a year, plan to contribute more than $50,000 annually to their retirement and have five or fewer employees.

Sponsoring a defined-benefit plan for employees provides them with a determined monthly benefit upon retirement. Defined-benefit plans can be structured to reward employees who stay with the company while minimizing retirement benefits to those employees with short tenures. Participants are not taxed on the retirement benefit until they actually receive a distribution from the defined-benefit plan. An added benefit to the small business owner is that employer contributions provided to a defined-benefit plan are fully deductible as an ordinary business expense.

When considering sponsoring a defined-benefit plan, small business owners must also consider the costs and expenses associated with operating a defined-benefit plan. Such expenses include:

Funding the defined-benefit plan

Retaining an actuary to determine the amount of the employer contributions

Insurance premiums for the defined-benefit plan if the business has more than 26 employees

However, the advantages of defined-benefit plans often outweigh these expenses for small business owners in their late 40s, early 50s or older who meet the following criteria:

They want to maximize their annual retirement contribution and are seeking the maximum tax deduction

The company has stable cash flow

The company has no employees, few employees or a number of employees who are significantly younger than the owner

Small business and professional service firms have more options when saving for retirement than they are aware of. The Pension Protection Act of 2006 makes the hybrid defined benefit plan a great alternative for many business owners.

Please comment or call to discuss how this affect you and you company.

When the demographics of a business are right the defined benefit hybrid plan is a great option for many small business owners as well as professional service firms. Assets in a qualified retirement plan provide asset protection from creditors and an accelerated saving rate, up to $250,000 deduction. Many small business owners and professionals are guilty of not saving enough for retirement. This option gives them the opportunity to catch up.
English: Retirement savings for various periods with squirrel and nut analogy (Photo credit: Wikipedia)

Would an extra $2.5 million come in handy at retirement? Would you like to defer taxes on over $200,000 of current income each year? Would you like to see a higher proportion of your retirement plan expense go to yourself, or your key people if you own a business?Whether you are a realtor, consultant, physician, attorney, independent contractor, sole proprietor, owner or a partner in a small or large business, you can turbo-charge your retirement with a cash balance plan on top of your existing 401(k) plan. You can be a one person shop, or highly paid executive or professional in a large firm.

The 401(k) plan, defined contribution, has become the sole source of retirement for more and more Americans. Just recently General Motors announced it will suspend its pension plan for salaried employees. All company contributions will be made to the 401(k) plan. In fact defined contribution dollar totals surpassed defined benefit plans, pension in 2011 for the first time. This trend will continue.

Remember the 401(k) plan was first introduced in 1981 as a supplement to a defined benefit plan by a bank seeking additional retirement funds for executives. It has been sold to companies, as a supplement, since then. It is time for plan sponsors to offer a plan that looks and acts more like the defined benefit pension plan. Currently plans offer a list of funds and the employee is expected to choose the right mix for their situation. This is usually done by looking at the past performance of the funds offered and choosing the funds with the highest performance. This is a huge mistake and often results in unacceptable results.

It is a mistake to offer a huge amount of fund choices and expect employees to make the right decisions. It is important to understand that providing too many choices is a bad thing. The more choices you include in your 401(k) plan, the higher the likelihood that the plan participants will do nothing and simply not participate in the plan or incorrectly allocate their funds.

Most plan participants feel uncomfortable and confused about how to best allocate their 401(k) contributions. When the employee is ready to retire the confusion continues with how to take distributions to make their savings last a lifetime.

As a result of the Pension Protection Act of 2006 401(k) plan sponsors can direct their employees to professionally managed risk adjusted model portfolios based on age. The employee then has the option to change the level of risk or opt out of the models and choose their own mix. Studies have shown that a majority of plan participants will remain in the original model portfolio. The result will be improved performance and less anxiety for the participant. When uncertainty is reduced participants will save more and worry less.

Please comment or call to discuss how your company 401(k) plan can be improved and become the employee benefit you and your employees deserve.

Without a benchmark analysis of their company sponsored retirment plan, plan sponsors will not be competitve for top talented employees. The trend is for employees to take a serious look at the quality of employee benefits offered by their prospective employer as well as its competitors. The retirement plan offered must provide the employee with the most efficient tools of reaching their long term retirement goals. Remember the 401(k) is no longer a supplement to a defined benefit plan but rather, for most Americans, the sole source of retirement funds

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Comparing Your Plan vs. Competitors’ Plans – If the goal is truly to provide a benefit that makes the plan sponsor’s firm a better workplace than the plan sponsor’s competitors then: a) plan sponsors must know what’s unique about their plan; and, b) plan sponsors must know what their competitors offer. Of course, it’s often difficult for one plan sponsor to gather intelligence on another plan sponsor. This is where reliance on third party benchmarking providers becomes important. This is really the meat of the subject in the next two installments of this series.

Creating a written record of the 401k plan’s history forms the foundation for a good fiduciary compliance review. It can also reveal some cracks – like missing or outdated information – that might need to be filled in before moving on. Ultimately, it sets the table that will allow plan sponsors to independently benchmark their plans.

Since the decline of the defined benefit plan, ie, pension plans, employees have become responsible and accountable for their own retirement future. These rules will help everyone reach their financial goals.

1. 30%
The percentage of all workers who have $0 in retirement savings. It is a strong measure of the ineffectiveness of the current retirement plan system for retirement plan accumulations. At the other end of the spectrum, million-dollar retirement accountbalances are a true rarity, comprising less than 1% of all account balances at one leading retirement plan provider.

2. 40%
The percentage of all workers currently not saving for retirement at all. Though less shocking than the retirement savings figure, this number might be even more significant. Suppose this group represented the bottom 40% of worker incomes (it doesn’t.) A significant number of those individuals would not have a sufficient portion of their retirement covered by Social Security to retire, so additional retirement savings would be critical for them.

If the 40% figure covers any appreciable segment of middle-income participants, it represents a true figure of retirement desperation, since such individuals are not poor enough to have significant income replacement from Social Security, but not rich enough to not need a high (70%) income-replacement level.

3. $250,000
The average savings shortfall a U.S. household will have at retirement. This figure actually includes Social Security, so it is all the more amazing. Where is the average family going to come up with an extra $250,000?

4. $52,000
The amount the average household needs in after-tax income for retirement. While Social Security will provide some of this income, the rest will be an accumulation of retirement savings, including voluntary and employer-provided retirement savings, if any exist. I am no math wizard, but even with Social Security, at least $1 million in accumulated retirement savings would be needed to provide this average household after-tax income. An extremely small portion of workers achieve such a savings. Thus, very few workers, except those with little income to replace, have adequate retirement savings, period.

5. 9.6%
The smallest recommended retirement savings rate for workers, taking into account Social Security. This figure may sound daunting, but keep in mind that it does not consider employer contributions to a retirement plan.

Past generations had no need to deal with these numbers because of defined benefit pension plans. Their employer took care of everything. Times have changed and employees need to become accountable for their own retirement future.

Retirement plan design is vital to the success of very plan. The cash balance plan should be considered by professional service firms, closely held small businesses, and any firm with solid cash flowlooking for additional tax deductions. This plan design will help attract and retain top talent.

Sigmund says that a cash balance pension plan is an especially popular tool for professional practices.

“If they have not maxed out their 401(k) plan, we recommend that they do so prior to establishing the cash balance pension plan. In combination, these two plans can enable the organization to cost effectively meet a variety of goals relative to the principles of the practice.”

The design of your company qualified retirement plan should be periodically reviewed to assure plan efficiency and compliance with new regulations.

Inefficient plan design wastes money because it either makes less cost effective contributions or it doesn’t maximize tax deductible contributions to highly compensated employees. So it either wastes money in unnecessary contributions or is inefficient for tax savings.In terms of wasting money, it could be a defined benefit plan that has outlived its usefulness or it could be a 401(k) plan with a new comparability plan design and a safe harbor matching contribution (because unlike a safe harbor 3% profit sharing contribution, you cannot use the safe harbor matching to offset any new comparability contributions to non-highly compensated employees like you could with the safe harbor 3% profit sharing contribution). A plan that doesn’t maximize contributions could be a 401(k) plan that consistently fails discrimination testing and doesn’t implement a safe harbor plan design or a plan that doesn’t offer a new comparability profit sharing allocation to highly compensated employees when the plan sponsor can afford it.

Retirement plans are a great employee benefit for retirement savings, but you should never forget the tax savings component it has.

There are many options with regard to retirement plan choices for your business. A proper analysis must be prepared to determine which option is best for you.

One of the difficult choices for an employer in deciding to sponsor a plan is which type of qualified plan to sponsor. Here is just a small list:

Number of employees to participate: The more, maybe not the merrier. But the more, is less likely you will be pursuing a defined benefit plan and more likely pursuing a 401(k) plan.

Age and compensation of the owner(s)/highly compensated employees. Despite what the folks protesting at Wall Street believe, one of the goals of setting up a retirement plan is saving the maximum for the owners and highly compensated employees of the business. One way to achieve the maximum savings is the use of a defined benefit plan or a cross tested allocation that will award higher contributions to these high paid employees and some of the key factors are age and compensation.

How much can the Employer afford to contribute? When it comes to defined benefit plans and safe harbor 401(k) allocations, as well as the near obsolete money purchase plans, the employer must dedicate a fixed contribution each year (which is decided after the end of the Plan Year). Does the Employer see that it has the cash flow over the next couple of years to make such a financial commitment? I can’t tell you how many times that I have had sole proprietors say they want to save the maximum under a defined benefit plan. All of a sudden, they needed to pare back after the sticker shock of the maximum contribution that the actuary determined.

Ask the Employees. A small business is usually not a democracy, but is may be wise to ask employees on the input of setting up a retirement plan. Namely the questionnaire really should be tailored towards trying to indentify whether they see this plan as an important employee benefit and if the employer decides the 401(k) route, whether the employees would defer. Now employees shouldn’t have a say in designing the plan since they aren’t going to be the ones funding the contribution.

Find a financial advisor. If a small business has a non-owner employee, a financial advisor should be hired. No ifs, ands, or buts.

Most Americans rely on their company 401(k) to fund their retirement. With the typical plan the employee must choose their mix of funds. This adds anxiety and results in no action toward their goal. Plans should become more pension fund like and leave the decisions to experts.

Still, the survey of 1,500 employees last month recorded an 18.2% decline in overall retirement confidence compared to September of 2010. More telling, there was a 31.7% drop in workers’ confidence that they will have both the defined benefitassets and employee health benefits they need to support a comfortable retirement when they’re done working.“This represents the most significant drop in retirement confidence we’ve seen in the four years we’ve compiled the Sun Life Unretirement Index,” Wes Thompson, president of Sun Life Financial U.S., says in a statement. “Although the recession officially ended in 2009, average Americans feel that the downturn has not ended for them, which is substantially eroding their trust in their retirement future.”

It’s so bad for some workers that one in five polled say they plan to never retire.

Only 23% of working Americans say they feel “very confident” that they will meet basic living expenses in retirement — way down from 42% who felt that way last year.

Confidence in the future of Social Security has plunged over the last four years, to 9% in 2011 from over double that (22%) in 2008 while confidence about Medicare benefits has also plummeted, to 8% in 2011 from 20% in 2008.

Plan sponsors can change this statistic by taking a more active role in the design and monitoring of their plan. Part of this role should include bench marking their plan against plans of similar sizes.

Please comment or call to discuss how this affects you and your company.

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